Confluence of factors drove recent sharp rise in energy prices

The global energy price shock that has impacted especially energy-intensive industries in major and emerging markets was driven by different local factors in various parts of the world.

Those factors include drought conditions in Brazil reducing hydropower output, a prolonged winter in Europe and the US and lower wind power production leading to higher energy and gas prices and coal in India and China, commercial risk and financial intelligence company Fitch Solutions global emerging markets economist John Ashbourne said during a webinar this week.

The most common theme across markets in terms of energy prices is supply shortage and, as is common in cyclical declines, energy producers were not able to react quickly to the burst in demand after the stage was set for a strong economic recovery following the Covid-19-induced recession in 2020, added Fitch Solutions head of oil and gas analysis Joseph Gatdula.

In addition to supply shortages, localised weather-related deviations from historical averages created conditions that exacerbated energy costs. Drought conditions in China, Northern Europe and South America reduced hydroelectric output and abnormally weak wind conditions contributed to low wind power in Europe for most of October and the extreme cold and prolonged winter experienced in 2020 saw supply disruptions in the US and extended the drawdown of natural gas stockpiles in Europe and China.

“Further, the Gulf of Mexico has not fully recovered from the impact of hurricanes, adding to a myriad of weather-related events that have tested markets and are likely to do so again in future,” he noted.

The confluence of factors, including a sharp economic recovery after lockdowns in 2020, saw domestic energy demand rise faster than producers could ramp up output, and fuel-switching from coal to gas and oil to gas supported price gains, as companies sought the most profitable means or least loss-making sources for power generation, said Gatdula.

Energy prices spiked in India owing to a shortage of coal and energy price rises in China, in particular, were driven by the significant increase in demand for energy from export-oriented industries, such as textiles and automotive production. In Brazil, the energy price shock was mostly owing to drought.

Price shocks in Europe, India, China and Brazil reinforced the push to natural gas, said Ashbourne.

All these separate causes, which would have worried the global economy if only one occurred, happened all at once, he added.

Fitch Solutions’ core view is that high natural gas prices are likely behind us, and the company is now bearish to neutral from spot in the short-term, although it expects volatility and prices to remain elevated well into 2022, said Fitch Solutions oil and gas industry analyst Adam Russell.

“The bullish factors in 2021 included a cold and prolonged winter and broader economic recovery and supply also met constraints.”

Similar factors in Asia led to a tightening of the energy market, which is exacerbated by the price premium these markets pay for liquefied natural gas.

There were two main impacts on the automotive industry owing to the high energy prices, the first being that some production was shut down as energy prices surged, although this was exacerbated by other factors, such as the semiconductor shortage for vehicle manufacturing and delays in, and higher prices for, shipping, said Fitch Solutions head of automotive analysis Anna-Marie Baisden.

These impacts occurred as much of the global economy recovered from the pandemic-induced shutdowns, but the impact was less severe than it would have been if global automotive supply chains were operating smoothly, she added.

Meanwhile, specialty chemical manufacturers are curtailing output and higher fertiliser prices and an inability to process livestock efficiently are impacting on agriculture, said Fitch Solutions commodities senior analyst Samuel Burman.

“The increase in crude oil prices leads to an increase in biofuel prices, and this places additional demand for feedstock, which puts pressure on prices of agricultural products. The higher oil prices also incentivised demand for palm oil.

“The increase in natural gas and coal prices also impact on the price of fertiliser as natural gas is used to create ammonia that is used to produce nitrogenous fertilisers, which are a source of nitrogen for plants to increase harvest yields.”

The higher natural gas prices place upward pressure on fertiliser prices and this motivates for the use of less fertiliser, albeit different for each market. Further, farmers are switching to crops that require less fertiliser, as seen in planting intention surveys, and are planting less staple crops such as corn (maize) in the US owing to the cost to fertilise and and in Asia, where rice is a staple, lots of producers are looking for ways to switch to other crops that use less fertiliser, said Burman.

“There have been some policy and government interventions, such as in Thailand, owing to concerns about higher food prices. The increased costs and demand are placing pressure on agriculture, and can lead to higher food and consumer prices,” he said.